I LOOOOVE LOOOOVE LOOOVE  this law, every last smelly comma of it.  It gets the second A+ I have ever given in my life.  Would vote for it with both hands and feet with my eyes closed.

Here are my summary reasons:

• I am late to the forum (deadlines crashing), and someone has to.
• The law is positively pithy and substance-filled next to your average law review volume.
• The law is one heck of a legislative feat in this political climate, if only for how closely it tracks the Administration's White Paper from June 2009 and the G-30 Report from the preceding winter.
• It does some good and no major harm for its central animating theory: systemic risk and macroprudential regulation. (I am with Brett here--and just look at the title sequence.)
• In the Glass-Steagall--BHC Act--FIRREA--FDCIA--Gramm-Leach-Bliley genealogy (which I prefer to the 1933-1934-SOX genealogy, given the animating theory), Dodd-Frank is second only to Glass-Steagall. And Dodd-Frank gets a lot more lovable if thought of as financial modernization, rather than crisis elimination.
• Dodd-Frank took what opportunity there was. Glass-Steagall passed four years after the crash, after every state in the Union had imposed a bank holiday, farmers with pitchforks were storming courthouses, and some cities had 90% unemployment. And this picture of JP Morgan Jr. was scandalizing the front pages. In contrast, Jamie Dimon looks like Clark Gable brooding over coffee in modern-day crisis pulp.
• If Dodd-Frank had surgically addressed the causes and management of this crisis, it would have been fighting the last war. In fact, I wince more where it does just that (e.g., requiring Fed 13(3) lending to be "broadly available" in what is an incredibly concentrated financial sector, Sec. 1101(a), and the ensuing ode to the liquidity- solvency distinction). Even so, I think the law does a serviceable job of looking ahead to where the risks might come from going forward, based on the experience of the last two decades. Will it save us from the next one? Of course not. Will it make it marginally easier to deal with the next one? Probably.
• I think the Fed and the FDIC are both good eggs on balance, and have done well in the law--including the balance of power between them.  I am also glad at the relative autonomy of the consumer protection function, which had no prayer embedded in prudential regulation.
• I suspect that the Volcker Rule might put some downward pressure on the size and transaction volume in the effectively insured financial sector. It is fairly blunt and indirect, but then again, it is not like PUHCA and the Tobin Tax were the likely alternative.
• Like many others, I see the rampant delegationism as inevitable. The multitudinous audit and Congressional reporting requirements are meant to compensate, I think. Does this mean new opportunity for capture? Sure. Net more capture? Doubt it.
• I don't mind studies when they preempt goofy law. Others have addressed some of the bigger examples, but for one little one, Sec. 989F mandates a GAO study of person-to-person lending (think Prosper, Kiva) with a view to potential regulation. This sector is growing super-fast, has tremendous domestic and international development potential, and fits badly in the existing regulatory structure. When Kevin Davis and I tried to think this through last winter, we found no systematic studies to guide the way. Yet the House had twice proposed a provision that would have the consumer bureau regulating P2P platforms, which basically addressed a specific SEC enforcement action and offered no predicate or vision for the sector as a whole. Study away, I say.
• In all, I think Dodd-Frank is about making modern diversified and interconnected financial institutions more regulable. This is most explicit in Title I, and I basically buy the way in which it goes about the task.

Now, Erik, I know you will ask whether there is one teensy weensy little thing I do not like about Dodd-Frank.  I suppose Sec. 1501 (instructing the U.S. to vote against IMF loans unlikely to be repaid in full) just about defines fecklessness--but what's a little fecklessness among friends?  Soft bigotry of low expectations, you say?  Did I mention I LOOOOOVE the font?

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I mentioned before that one big idea of Dodd-Frank was almost Goldman Sachs.  However, over time, the Goldman-specific provisions were watered down or taken out completely.  Section 913 seems like a strange compromise on a Goldman-specific idea:  imposing fiduciary duties on brokers. 

This argument has come up lately a few times with regard to Goldman.  First, Goldman testified in front of Congress in April, and was asked about this question.  Erik blogged about it and gave a round-up of links to writers and bloggers on the topic of fiduciary duties for securities brokers.  Here's another post from Erik on the SEC suit against Goldman (now settled) where Goldman's obvious defense was that it owed no fiduciary duties to its brokerage clients.

So, Dodd-Frank does away with this big distinction between brokers and investment advisors, right?  Um, not really.  Section 913 almost does.  What does it do?  Section 913 requires the SEC to study the effectiveness of the standard of care for brokers who give investment advice to retail customers.  Study this.  Then, the SEC must submit a report 6 months from (I guess) today.  Then, the SEC can engage in any rulemaking necessary to address the standard of care.  To make this easier, Dodd-Frank goes ahead and amends 15 U.S.C. 78o(k) to authorize the SEC to promulgate rules to establish that the standard of care for brokers giving personalized investment advice to retail customers is the same as that for investment advisers under the Investment Adviser Act.  Does this mean that broker fiduciary duty is a foregone conclusion?  I'm not sure.  Rulemaking, as others have pointed out here, is different from legislating.  Broker fiduciary duty might go the way of attorney "up the ladder" reporting after Sarbanes-Oxley. 

And, it will only apply to retail customers, who are defined as natural persons.  So, Goldman is off the hook.  Even if this duty had existed before the Abacus deal, Goldman would not have owed a fiduciary duty to its non-retail client.

UPDATE:  Our own Glom Master Larry Ribstein also testified at the hearing mentioned above and tells me that the SEC will follow through and promulgate rules as per Dodd-Frank, creating an identical duty for brokers along the lines of investment advisers.  So, this may be a done deal.  Larry also reminds me that this debate was going on before the Goldman Abacus suit, which may answer the retail customer question.  Here is Larry's response to Erik's April post on broker fiduciary duties following the hearing.  Once this is a done deal, there will be some great opportunities for research.  In my experience, those who would manage retail customers personal rollover IRAs seem to charge more if you choose a fiduciary duty relationship, so there may be great unintended consequences here.

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So, in the interview portion of our financial reform pageant, Erik asked me as a follow up to my Dodd-Frank & Madoff post:

Christine: What grade would you give to the Dodd-Frank provisions designed to make sure the SEC doesn’t drop the ball with future Madoffs? Do the provisions, including the bounty, ensure the SEC does the enforcement job it already has? Are there lessons for making other financial regulators more accountable and diligent? Are you worried about overzealous enforcement now?

I hate to say this, but I think Ponzi schemes are inevitable. Teenagers will always tell each other they love them to induce them to act in certain ways, and con artists will always be there to offer you unbelievable returns.  Regulating against human nature is impossible.  We have murder laws, but we'll always have murder.  So, the question is can any regulation help the SEC spot the Ponzi scheme before people lose money. 

First, Ponzi schemes aren't really illegal until someone doesn't get their money back.  Perhaps the schemes (like Madoff's) where he claims to make an investment and then doesn't do anything at all could be prosecuted prior to its collapse, but it would be hard to do.  Or, if someone holds himself out as something he isn't -- broker, investment adviser, etc. or offer an unregistered security.  Sometimes the SEC finds an ongoing scheme and in investigating, gets the target to obstruct justice or make a false statement, but usually someone has to lose money and complain about it first.  So, pretty much someone has to lose money before we can step in and prosecute.  So, it's hard to write any new SEC procedures that will prevent at least some loss.

In Madoff's case, there would have been some losses no matter when an investigation brought the scheme down, but fewer than in 2008 presumably.  But, someone at the SEC would have had to take complaints seriously.  Ironically, having a bounty system may create a greater number of credible complaints, leading the SEC to view them all with skepticism (a sort of market of lemons problem).  Remember, one of the reasons that the SEC was skeptical of Markopolos was because he wanted a reward.  Whistleblower protections may induce credible complaints, but bounties may induce an equal number of non-credible ones.

Madoff was also able to continue for a long time because he was an insider and human nature made the SEC investigators not suspect him.  Most garden variety Ponzi schemes are by industry outsiders, and the SEC is very good about prosecuting those low-hanging fruits.  Will regulation make SEC individuals rise above human nature?  No, but now experience will educate investigators to look out for insiders as well as outsiders.

Finally, Ponzi schemes will always pop up as long as their are people who want to make high returns in a quick period of time.  Human nature makes the victims look past red flags, particularly with affinity fraud.  Regulation can't really do much about that.

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There's lots that could have been better about the financial reform bill - I have my own views on the right way to handle resolution authority, the leverage caps could be stronger (though I think they are coming through the Collins Amendment and Basel III), and the systemic risk regulation council approach to coordinated oversight could amount to precisely nothing.  But passing legislation is an exercise in the art of the possible, and the act moves a lot of shadow finance into the light, where supervision is at least possible.  It starts down the road of rationalization in insurance, in coordinated supervision, and it embraces the globalization of finance by globalizing many of the rules by which banks must pay.  I like incremental reform, and I'm impressed by everything that is there.  So I think the President should be glad to be able to be in this picture.

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I ask the question not because I believe they are warranted, but rather because we have been discussing comparisons between this new Act and Sarbanes-Oxley and those comparisons got me thinking about one striking difference between the two acts in terms of the emphasis on criminal sanctions.  With Sarbanes-Oxley, there was a lot of discussion about the need for personal accountability, which ultimately translated into a push for increased liability for corporate executives, and hence provisions imposing enhanced criminal penalties related to various frauds, including sanctions for executives' false ceritification of financial reports.  This time, such a push has not been a central focus of reform efforts.  In fact, even though this new Act uses the term "accountability," it does not even have the same connotation as it did under Sarbanes-Oxley.  Which raises the question, why not?  Here are some possibilities.

1. Perp Walk Fatigue.  Certainly the debacles associated with Enron and other corporate giants featured a lot of "perp walks" as evidence of the government's efforts to curb misconduct.  Perhaps the American public no longer has the appetite for such perp walks.  Indeed, perhaps the fact that the first criminal case of executives accused of conduct stemming from the financial crisis ended in acquittal reflects this lack of appetite.  Of course, it also could just indicate that the complexity of this current crisis does not lend itself to the kind of criminal prosecutions we saw last time.  Moreover, it suggest that the perp walk may not have the same impact in the context of this current crisis, and hence reform efforts cannot have the same emphasis.

2. All Out of Sanctions.  In light of the emphasis on criminal sanctions under Sarbanes-Oxley, perhaps the lack of emphasis in these new reforms suggest that we already had reached a ceiling, or close to a ceiling, with respect to increasing criminal sanctions in this area--and hence there was no new ground to cover.  Of course, one can argue that this potential did not stop us before.  That is, many people criticized Sarbanes-Oxley precisely because it appeared to impose additional penalties related to conduct for which penalties already existed.  

3. Been There, Done That.  Another possibility is that we have come to realize that enhanced criminal sanctions have a limited impact in terms of their ability to prevent corporate fraud and other forms of misconduct.  Indeed, one could argue that the fact that our last reform effort focused on enhanced penalties, and yet failed to prevent this current crisis, suggest something about the utility of such a focus.  To be sure, given the complexity of this current crisis, drawing such a conclusion may be entirely inappropriate, but it nevertheless may have played a rule in the relative de-emphasis on criminal sanctions under this new Act.

4. Once Bitten, Twice Shy.  Then too, it could be that the Supreme Court's reaction to the use (and some would say over-use) of criminal sanctions in cases like those involving Arthur Andersen and Jeff Skilling, has made us reluctant to rely on such sanctions.

5. No Bad Guys (or Gals), Just Bad Companies.  Another possibility is that, unlike before, there are no clearly identifiable executives accused of wrong-doing who have become (or can become) household names.  And perhaps the fact that we cannot pinpoint many bad guys (just the bad companies) makes it hard to utilize the criminal sanction process.  This observation also could just confirm the broader nature of this crisis as opposed to the one Sarbanes-Oxley was aimed at tackling.

Whatever the reason--and I am sure people can think of more--it does seem like one stark difference between Sarbanes-Oxley and this new Act is the virtual lack of emphasis on enhancing criminal sanctions.  I am not sure if that is a theory or theme, but it certainly struck me as a key change.

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Erik asked me to answer my own question: Are shareholders the problem or the solution?  Here's my stab at it.   I enjoyed Renee's question, What's the big idea behind Dodd-Frank?  Christine's makes a good case for Bernie Madoff as the animating principle behind some sections of the Act.  I'd argue "Shareholders to the rescue" is the big idea behind kitchen-sink Subtitle E of Title IX: Accountability and Executive Compensation.  Proxy access, say-on-pay, and even disclosure requirements are about keeping the feds from telling corporations what to do substantively and just giving shareholders a chance--a chance to vote, a chance to know more about what corporations are doing.  Brandeis' spirit is alive and well, at least in this subtitle.

But, as I've been thinking about in response to thoughtful and persistent questions from Vice Chancellor Strine, if the immediate shareholders of a corporation (mutual funds, hedge funds) are in it for the short-term, why expect them to care about the long-term health of corporations or act in their long-term interests?  The "corporations are bad because they serve greedy shareholders" story (see BP) resonates deeply with the same populist sentiment behind Section 953's mandated disclosure of the ratio of CEO's pay to median employee pay. But the stories are fundamentally contradictory: one allies manager and shareholder together against the rest of us, and the other pits manager against investor. 

Which is right?  A greedy, myopic shareholder might well want a greedy, short-termist CEO at the helm of her corporation, as long as their interests are aligned via pay for performance.  On the other hand, I'm mindful that proxy-access opponents, in particular, have often wrapped themselves in a mantle of virtuous long-termism that by another name smells like management entrenchment ("oh, those myopic shareholders, no understanding of delayed gratification, always in it for the quick buck!  Why can't they leave me alone?  Will I miss my 3:00 tee-time?"). 

Are shareholders the problem or the solution?  I'm still mulling.  But it's hard to see how they can be both,and that's what the populism behind financial reform seems to want them to be.

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Erik asks us how we would grade the Act as a whole, and whether we would have voted for it.  I seem to be more of a supporter than most posters here:  I would certainly have voted in favor, and I give it a solid B.  Unlike Renee, I think there is a big picture story which helps identify the core provisions.  After decades of deregulation, our financial system has become unstable as players loaded up on leverage and untested innovations, leaving the system vulnerable to episodes of panics and deleveraging which can bring down the entire economy.  There are two complementary stories of leverage and systemic risk.  The too big to fail story focuses on financial giants whose failure would rapidly spread to dozens of other connected firms.  The shadow banking story focuses on the ways that markets like repo, commercial paper, and money market funds resemble banks, with short-term debts financing long-term assets, and hence become subject to runs.  A major side story is the housing market, where the main bubble that led to the panic occurred.  There, securitization and abusive credit products helped create the dubious debts which eventually ignited the system.

The core provisions for addressing system instability are Titles I and II.  We addressed the banking system in the 30s with 3 main elements:  deposit insurance, FDIC resolution authority, and increased banking supervision.  There's no explicit insurance in Dodd-Frank, but the bailouts suggest that the federal government stands ready to prop up a failing financial system.  Title II replicates something close to FDIC resolution authority for a broader range of financial institutions.  One element of Title II that I really like is its push to punish the officers of failed companies, through firing and restitution.  That may go a decent way to mitigate the moral hazard caused by the bailouts.  Title I extends supervision, including regulation of leverage, to a broader range of companies.  It should at least cover the too-big-to-fail companies.  It doesn't break them up, but it does direct regulators to impose heavier burdens on those companies, and gives them the power to break them up if they believe doing so is needed for financial stability.  Title I will probably do less to address smaller companies in the shadow banking system, though as I've noted before that depends on how aggressive the Council is in interpreting its authority.  Title IV (hedge fund advisers) should at least give regulators more information about what is happening in many companies within the shadow banking system.  Title VII address another important source of financial instability, swaps with their counterparty risks that create doubts throughout the system.  The creation of derivative clearinghouses is likely a good idea, although it creates its own risks, and as always the devil is in the details.

Dodd-Frank also addresses the problems in the housing market.  Title X creates the Bureau of Consumer Financial Protection.  Consumer protection and safeguarding financial stability are sometimes in serious tension with each other.  But, abusive credit products can ultimately lead to bad debts that cause problems in the financial system.  That is particularly so when originators sell off many of those debts through securitization, reducing their incentives to make sure loans will be repaid.  Who knows how aggressive the Bureau will be (Elizabeth Warren for Director!).  This idea may not work, but it's worth a try.  Title IX Subtitle D adds a 5% credit risk retention requirement for securitizations.  Again, I'm not sure it will work, but it's a serious attempt to address a real problem.  Finally, Title IX Subtitle C tries many tactics to improve the performance of credit rating agencies.  Most noteworthy are the extension of securities law liability to the agencies, and even more importantly the directive to remove credit ratings from regulatory requirements of all sorts (see sections 939 and 939A).  It's not clear to me exactly how far this goes--to what extent can agencies use credit ratings at all in their various rules?  But this could be a very big deal.  If you believe Frank Partnoy, a key reason for the success of credit rating agencies is that the many rules using credit ratings have created "regulatory licenses"--institutions buy highly-rated bonds in order to comply with administrative rules.  If those regulatory licenses are being eliminated, it may greatly reduce the role of the credit rating agencies.

Those core provisions strike me as serious attempts to address the main problems that the crisis has revealed.  There was even more moaning about the banking and securities acts of the 30s, but they created a regulatory framework that helped bring the longest period of financial stability in American history.  (And a side benefit for us law professors: this creates lots more work for our graduates over the next few years, and boy do they need it.)  Does the Act get at everything?  No, but there are good reasons for not trying to do so, one reason being that no one has any really good ideas about how to address some of the deepest problems.  Does the Act sustain uncertainty with all its forthcoming rules and studies?  Yes, but I argued yesterday that the alternatives aren't any better.  Will there be some bad unintended consequences that need to be fixed?  Of course, but doing nothing would probably be even worse.  We have a vast, unstable financial system which no one really understands in anything like the depth required to adequately regulate it, and yet unregulated it is likely to drive us into a Second Great Depression one of these days (and there's no good reason to think that the First Great Depression is as bad as it can get).  There are no good alternatives available.  Given all that, I think Dodd-Frank is quite a reasonable stab at an impossible task.

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Once again, Erik is pushing us all on our earlier posts.  He asks me:

Kim: Congress seeking to take credit and shift blame is not unique to financial regulation. It happens all the time in national security. What to do? Are reforms to the legislative process in order? Is it the job of courts to hold Congress’s feet to the fire? Maybe strike down overbroad or vague provisions and send them back to Congress? Or is that too draconian?

Not only is responsibility-shifting legislation not unique to financial regulation, it appears to be relatively less common there.  Legislators are reluctant to cede control over policy that permits a narrow tailoring of benefits to constituents (including a narrow tailoring of exemptions from legislation).  Most of the time, financial regulation appears to provide exactly these sorts of opportunities. 

But, as always, there are exceptions.  For example, the legislative history of the PSLRA (detailed by Grundfest and Pritchard, as well as by Baker and me) suggests that Congress left the "strong inference" provision of the Private Securities Litigation Reform Act of 1995 strategically incomplete.  But, two extremely powerful interest groups--trial lawyers and issuers of securities--were on competing sides of that issue. If possible, rational legislators might go to great lengths (including delegating responsibility to the courts through vague or ambiguous statutory language) to avoid fully alienating either group.

As I noted in my post yesterday, the political conditions leading up to Dodd-Frank were ripe for a responsibility-shifting delegation. The benefits of financial regulation are widely dispersed and barely noticed and a powerful interest group (financial institutions) has an intense interest in the legislative outcome. But, in the wake of the financial crisis, financial regulation has become a high public salience issue, limiting Congressional options. Whether there is similar evidence of responsibility shifting in Dodd-Frank awaits a detailed review of the legislative history. 

So, what to do?  Few things in life are too draconian for me, as you should know by now, Erik.  We develop a three-part test to determine whether a statutory provision is incomplete for strategic reasons, meaning that lawmakers created an intentionally incomplete statute in an attempt to shift responsibility for the negative impacts of law to other governmental branches (the presumption is that they did not).  If all three prongs of the test are met, then the court should penalize lawmakers by holding that the provision is so incomplete that it amounts to an unconstitutional delegation of legislative authority.  Anyone familiar with non-delegation jurisprudence can easily predict the likelihood (about zero) that the courts would follow this path.

Finally, would I have voted for the Act?  If I were a law professor, no, for all of the reasons I mentioned yesterday (sometimes, in my dreams, law professors are invited to vote on important legislation and cases, given free NCAA Final Four tickets, or flown to the Tour de France mountain stages.)

If I were a democratic senator, yes.  I would vote for it and give a speech about ending “too big to fail” and restoring American confidence in the financial system.  If I were a republican senator, no.  I would vote against it and give a speech about how the legislation doesn’t do enough to reign in the big banks or put a stop to Wall Street bailouts.  

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Dodd-Frank, like Sarbanes-Oxley (and numerous other legislative enactments in and outside securities regulation) before it, includes provisions mandating and permitting specified "studies" of matters not fully resolved by the provisions in the legislation.  I often have wondered about these types of provisions.  I have more questions than answers.

• Why are these study provisions included in legislation?  Is it just congressional guilt about matters not covered?  Is there a genuine interest in the outcomes for purposes of follow-on legislation, rule-making, or agency operational changes?  Is this a weak attempt at fostering extra-legislative change?  
• Are all of the studies concluded?  Legislative provisions requiring studies generally set deadlines.  Are these deadlines met?
• Who conducts these studies within the appointed agencies?  What is their training in empirical research?
• And what ever comes of these studies?  Are public reports always issued (since, under mandatory study provisions, reports typically are required)?  How often does legislation or rule-making or policy/process modification result?

There are reports on outcomes of SEC studies commissioned under Sarbanes-Oxley published on the SEC Web site.  The ones I have reviewed are principally data assembly documents, with no or little econometric analysis.  Some include reform proposals.  In general, the studies I have sampled don't offer me much comfort that helpful analyses are being performed and used in rule-making, enforcement, or related SEC operations.  But I invite folks who know more to disabuse me of that notion, at least in specific circumstances.

The Dodd-Frank legislation includes a general authority provision for SEC studies that particularly intrigues me.  The text is included in Section 912, which reads in relevant part as follows:

SEC. 912. CLARIFICATION OF AUTHORITY OF THE COMMISSION TO ENGAGE IN INVESTOR TESTING.

Section 19 of the Securities Act of 1933 (15 U.S.C. 77s) is amended by adding at the end the following:

(e) Evaluation of Rules or Programs- For the purpose of evaluating any rule or program of the Commission issued or carried out under any provision of the securities laws, as defined in section 3 of the Securities Exchange Act of 1934 (15 U.S.C. 78c), and the purposes of considering, proposing, adopting, or engaging in any such rule or program or developing new rules or programs, the Commission may--

(1) gather information from and communicate with investors or other members of the public;

(2) engage in such temporary investor testing programs as the Commission determines are in the public interest or would protect investors; and

(3) consult with academics and consultants, as necessary to carry out this subsection.

I am not sure why "clarification" is needed here.  Doesn't the SEC already (implicitly, if not explicitly) have broad authority to conduct activities related to its rule-making authority?  Will this provision be interpreted as narrowing that broad perceived authority?  I should hope not.

On a more positive note, it does look like some of us may get some action out of this (or at least the legislation suggests that possibility in referring to the potential involvement of "academics and consultants").  This may give us additional reasons to care about the Dodd-Frank bill on a going forward basis, as we work through our research agendas.  Some of the issues discussed in this forum, for example, could (and should) be fleshed out and potentially resolved with the assistance of law, economics, finance, and accounting experts if this provision is interpreted broadly and has real teeth.  I still wonder about all that. . . .

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Here is a second round of questions for our Masters based on yesterday’s posts, or what I like to call “Put your favorite law professors on the spot!”:

Christine: What grade would you give to the Dodd-Frank provisions designed to make sure the SEC doesn’t drop the ball with future Madoffs? Do the provisions, including the bounty, ensure the SEC does the enforcement job it already has? Are there lessons for making other financial regulators more accountable and diligent? Are you worried about overzealous enforcement now?

Kim: Congress seeking to take credit and shift blame is not unique to financial regulation. It happens all the time in national security. What to do? Are reforms to the legislative process in order? Is it the job of courts to hold Congress’s feet to the fire? Maybe strike down overbroad or vague provisions and send them back to Congress? Or is that too draconian?

Larry: Do you take any comfort in the fact that Wall Street firms have the resources, incentives, and opportunities –either in the regulatory process, litigation, or subsequent litigation – to trim back the provisions you find to be overkill?  Under your (and Butler's) proposals for continued state regulation of insurance, should bond insurance be an exception in which the feds take charge?

Lisa: Is there any value to a non-binding shareholder vote? You write: “Ultimately, if the reform bill has managed to make proxy access a reality, then at the very least it will be responsible for finally resolving the long-standing debate about the benefits of such access. Time will tell if such a resolution is a good or bad thing.” How would we judge whether proxy access is a success? Is success for the agency cost argument for broader shareholder access to the ballot easier to measure than for the broader stakeholder argument? Which of these two sides to proxy access stands to gain more from Dodd-Frank?

Michelle: What do you think of Mark Roe’s argument that providing various exemptions in Ch. 11 (from the automatic stay) for derivative counterparties exacerbated the crisis?  Did these exemptions warp the incentives of derivatives counterparties to monitor and discipline debtors? Is this a hole in Dodd-Frank?

Mike: You wrote: In this respect, [Brandeis] would probably applaud the Goldman Sachs case brought by the SEC more than the Dodd-Frank Act. In the Goldman Sachs case, Brandeis would see that the SEC got it just right. “ What deterrence value do you think the SEC-Goldman settlement will have? Turning back to Dodd-Frank, do you think it is time to revisit the regulatory distinction between derivatives and securities?

Renee: To play devil's advocate: does a statute need a big idea or it it acceptable to find that lots of factors contributed to the crisis and it was prudential  for Congress to address a number of them? 

Usha: You had one of the more provocative titles to a post yesterday: “Are Shareholders the Problem or the Solution?” What would be your answer to the question? Do you buy Leo Strine’s argument that we should be concerned about shareholders with a short-term focus exercising too much power?

To everyone: Here are a few questions to put you on the spot.

• Would you have voted for the Act?
• What grade would you give the Act?
• Will the Act make it into your lesson plans?

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Louis Brandeis famously coined the metaphor (“sunlight is the best policeman”) that provided the philosophy underpinning the first federal securities acts (disclosure, disclosure, and more disclosure).  I thought it might be fun to run a thought experiment:  what would the intellectual father of federal securities regulation think of the Dodd-Frank Act? 

 

On initial review, Brandeis might be proud of his metaphor's place in the new Act.  An entire section of the Dodd-Frank Act (Section VII) goes by the name: “Wall Street Transparency and Accountability.”  But on closer inspection, the ways in which disclosure rules are used in the Dodd-Frank Act deviate substantially from the Brandeis’ tradition and are clearly secondary to the new Act’s main interventions.  This is, however, as it should be.  Notwithstanding the many add-ons, the Dodd-Frank Act is fundamentally an act about prudential regulation, and public disclosure is not a tool that is specially tailored to address prudential regulation.

 

Why disclosure of prices in derivatives markets?

 

The application of disclosure rules in Section VII of the Dodd-Frank Act is focused on facilitating price discovery in the derivatives markets.  This is an odd place to worry about price discovery. In general, uncertainty about prices allows a seller to carry out price discrimination (think of trying to get a good deal at your local mattress store, when the mattresses at every store have a different name).  The effect of price discrimination is to transfer consumer surplus from buyer to seller, but there is no economic efficiency cost.  So, in requiring public markets in derivatives, we are seeing a form of “consumer” protection, but this time for sophisticated investors.  Why protect one group of sophisticated investors from another group of sophisticated investors?  Aha: truth be told, the legislation implicitly recognizes that many of these so-called sophisticated investors really may benefit from legislated investor protection (perhaps, for the reasons that Gordon’s post highlights).

 

Another possible justification for requiring public trading of derivatives is that price information may generate positive externalities.  Public information about derivatives pricing can be used to price the option component of a portfolio.  What if you are planning to replicate a put strategy on the market by executing a portfolio insurance program?  One way to see how much such a strategy is likely to cost is to look up the prices of the publicly traded derivatives necessary to replicate your strategy. But federal intervention is almost certainly not necessary for this purpose, since the required derivatives price information is generally already publicly available.

 

Disclosure is secondary here (as it should be)

 

A second aspect that might strike Brandeis as surprising on reviewing the Dodd-Frank Act is just how far the main thrust of regulatory intervention has moved away from disclosure requirements.  The preferred approach of the Dodd-Frank Act appears to be: require a study and a set of regulations to be written, as noted by others in their posts.  On this score, I tend to agree with Brett that the drafters of the Dodd-Frank Act are probably doing the correct thing.  At the most general level, regulating systemic risk and imposing leverage restrictions are jobs for a prudential regulator, not a fully informed public market or a legislator.

Nothing for the shadow banking system?

 

So we have a new disclosure scheme to help so-called sophisticated investors, and we have an expanded bureaucracy aimed at hunting and destroying systemic risk. What about the huge grey area that Erik describes as a shadow-banking system or what Bret identifies as the “systemic collapse [that] can occur when many medium-size institutions in linked markets follow similar investment strategies?”  First, I have a hard time distinguishing concerns about a shadow-banking system from concerns about securities markets generally.  So this leads to the question of how we prevent securities markets from getting “overheated.”

 

Why doesn’t the Dodd-Frank Act do a better job of dealing with potentially problematic shadow banking system/securities markets weaknesses?  The answer is simple.  Just as we don’t really quite know how to legislate effective prudential regulation, no one has yet offered a particularly good answer on how to regulate securities markets in a way that appropriately mitigates booms and busts.

 

My guess would be that Brandeis would fall back to his old favorite (disclosure) as the best place to start.  He would continue to insist on full and honest disclosure in all transactions for a host of reasons.  In this respect, he would probably applaud the Goldman Sachs case brought by the SEC more than the Dodd-Frank Act.  In the Goldman Sachs case, Brandeis would see that the SEC got it just right.  Implicit in the Dodd-Frank Act is the realization that many sophisticated investors may need to be protected too.  With sophisticated investors, the federal government might not be in the business of dictating exactly what needs to be disclosed, but the SEC is still right to apply two general criteria to determine which disclosures are necessary: requiring both full disclosure of any potential conflicts of interest (“agency” information as Paul Mahoney aptly refers to it) and full disclosure of all relevant accuracy enhancing information.  Both types of information are material, even if the effect of requiring disclosure of the former is only to deter untoward behavior, not to increase the accuracy of securities prices.

 

In conclusion, with the original securities acts, we had a relatively simple prescription – more disclosure – to address a host of ailments.  With the Dodd-Frank Act, we are given a host of prescriptions in an attempt to deal with one seemingly perennial problem: the eventual demise of prudential regulation.  My bet is Brandeis would insist that we not forget to continue to rely on well-enforced disclosure rules, in addition to panoply of new rules to protect against a future that may well ultimately be determined by unexpected market dynamics.  There may some wisdom in such an approach.

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Like many, I am skeptical that the Dodd-Frank Act accomplishes much of anything.  It does provide nice photo ops and plenty of ammunition (on both sides of the political spectrum) for the mid-term elections.  It also reminds us of the lobbyists' ability to influence legislation (see, e.g., Gordon’s post here and reference to auto dealer exemption here).  But does it fix all, or even some, of what contributed to the financial crisis?

Given the number of contributing factors and the breadth of the legislation, I am just going to say a few words about one piece of this puzzle—the resolution authority granted the federal government under the Act.  The resolution or “orderly liquidation” authority described in the Act sounds terrific. (Former Secretary Paulson reportedly commented that he “would have loved to have something like this for Lehman Brothers.”)  It basically allows the FDIC to place specified financial institutions—e.g., bank holding companies and broker-dealers determined to pose systemic risk to the U.S. economy—into receivership.  (See generally Title II of the Act; see concise summaries here and here.)  The Act grants the FDIC extensive authority to operate the business and liquidate the assets of, and resolve claims against, the financial institution.

At first glance, the orderly liquidation process set forth in the Dodd-Frank Act resembles a chapter 7 or a liquidating chapter 11 case under the U.S. Bankruptcy Code.  Indeed, in bankruptcy, a trustee, examiner or alternative management team can be imposed; assets can be sold (often free and clear of any claims, liens or encumbrances against the bankrupt company or its assets); and special provisions exist for the treatment of certain derivatives and counterparty obligations (I mention the derivative provisions because they also appear in the Act, not because they are necessarily effective, see here).  Notably missing from the Dodd-Frank Act but present under the Bankruptcy Code, however, is a concern for stakeholders’ rights.

Yes, the Dodd-Frank Act provides that the FDIC must observe certain claim priorities, but the ability of stakeholders to participate in the process—even the claims resolution process—is very limited and cumbersome.  For example, if a creditor wants to object to the treatment of its claim proposed by the FDIC, it must file suit in the district court where the financial institution’s principal place of business is located; a district court that will be unfamiliar with the company and the circumstances surrounding the case and the claim.  Likewise, the FDIC has the ability to assume, assign or reject the financial institution’s contracts, but the rights of the non-defaulting parties to those contracts are unclear.  Moreover, the FDIC can pursue fraudulent conveyance and preference claims, but again the process is murky.

Why create all of this uncertainty when we have a perfectly viable tool in the U.S. Bankruptcy Code?  Now, some of you may be scoffing and pointing to Lehman Brothers as Exhibit A in the case against the Bankruptcy Code.  I would simply suggest that the Bankruptcy Code did not fail in Lehman Brothers; rather, the parties failed to invoke the bankruptcy alternative in a timely and effective manner.  And at least in the bankruptcy context, all parties understand the process and can react in a manner that not only may further the debtor’s case, but also protects their own interests.  I worry that in focusing so intensely on those institutions that may pose a systemic risk to the U.S. economy, we may be creating a process that hamstrings the businesses and stakeholders who drive that very economy.  Perhaps this issue will be considered in the study on the bankruptcy of financial and non-financial institutions (one of the many studies) mandated by the Act.

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Renee compares the Dodd-Frank reforms to Sarbanes-Oxley and wonders what the cohesive theory is behind Dodd-Frank.  Sarbanes-Oxley had Enron and Arthur Andersen as villains, and accounting fraud as the bad act.  Some things to remember:  First, SOX was passed quickly, very soon after the fall of Enron, WorldCom, and Arthur Andersen.  Enron fell in late 2001; WorldCom in June 2002.  SOX was passed in July 2002, unanimously by the Senate and with only 3 "nea" votes in the House.  There was very little horse-trading there, and not much time for lobbying by industry.  This quickness has two sides -- on the one hand, the reforms were meaningful and substantial.  On the other hand, they may have been knee-jerk reactions to the perceived causes with little time for study.  Dodd-Frank, however, comes now almost two years after the beginning of the crisis.  Even if a year ago, the financial reform bill started out with big-picture themes (End Too Big To Fail, Curb Systemic Risk, Punish the Casino-Makers) and clear villains (AIG, Lehman, Goldman, Madoff), after months of lobbying and deal-making, not much of a theme remains (remember the now-defunct Bank Tax?)  But the one villain we can all agree on is Bernard Madoff, and he is very much alive in this financial reform.

First, "Improvements to the Management of the Securities and Exchange Commission" beginning in Section 961 sets out to make sure that no one ever drops the ball on a Madoff again.  The only problem is how to actually do that.  How do you make sure that no one is ever blinded to a charismatic industry player and ignores an unpleasant whistleblower who seems like a money-grubbing competitor?  Well, we make the SEC write a lot of reports, do a once-over study, hire a lot of examiners, and set up an employee hotline.  We also study the "revolving door" to identify when investigators might be going easy on examinees so that they can line up employment later.  An earlier version of the House bill had contained a Section 7306, which required the SEC to report to Congress on "implementation of post-Madoff reforms," but I think the passage of time took care of that requirement.  Then, Section 991 appropriates certain amounts to the SEC, and I'll just assume those are budgetary increases so that the SEC can't play the pauper when frauds go through the cracks.

Second, Section 922 provides for a reward system for whistleblowers, in addition to additional protections, closing up some gaps in federal whistleblower protections.  Whistleblowers must provide original information to officials regarding violations that end in a successful enforcement action by the SEC.  A qualifying whistleblower, who may be anonymous and act through counsel, would then receive between 10 and 30% of any fine or disgorgement over $1 million, at the SEC's discretion.  Though commenters see the most action with this section in FCPA enforcement, where fines are high and liability is strict, this is basically designed so the employees of the next Madoff will have an incentive to give information earlier.  (They seem perfectly incentivized to tell everything they know once an indictment is assured.)  In addition, the existence of this provision puts pressure on the SEC to develop information early and to listen to the Harry Markopoloses of the world.

Finally, SIPC.  I have blogged about some of the SIPC issues litigated in the Madoff liquidation here ("net equity") and here ("net winner" and "direct customer").  Because Bernard L. Madoff Investment Securities was a member of SIPC, direct customers who lost assets as a result of the financial firm's "failure" were eligible for advances from SIPC of up to $500,000 to reimburse them pending liquidation.  If the firm's assets aren't sufficient to satisfy all claims, then the advance may be the only recovery.  Madoff victims testified to Congress about many of the shortcomings of SIPC, including the $500k cap, the definition of direct customer, and the definition of net equity.  Dodd-Frank has two sections devoted to SIPC (the Securities Investor Protection Corp.) and SIPA (the Act), but they don't cover these points.  Section 929H increases the limit of the cash advance limit.  If you invested cash with a fraudster or a firm that then went defunct before converting your cash to a security, then you were entitled to an advance of up to $100,000.  That is now $250,000, indexed for inflation at SIPC's discretion.  No mention of the $500,000 limit on net equity after your cash has been converted.  Perhaps left for another day.  No mention of direct customer or net equity definitions.  Section 929V codifies the temporary increase SIPC had already instituted to reform the embarassingly low annual fee for SIPC members ($150 a year) to .02% of gross revenues.

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President Obama is set to sign Dodd-Frank into law tomorrow, and the consensus amongst Masters and Glommers seems to be, there's little cause for celebration, but much cause for discussion.  I've learned a lot already from the Forum, and urge readers to check out some lively discussion in the comments. 

I've been focusing on the corporate governance provisions in the bill, and have enjoyed both Christine and Lisa's posts. Christine seems to think of the executive compensation reform as much ado about nothing,  a politically cheap and easy way to claim "reform," and I'm inclined to agree.  What interests me is how the main regulatory tools here involve giving more information, votes, or proxy access to shareholders as a way to discipline managers.  I remember when the story was that the financial crisis was caused by managers acting to enrich shareholders at the expense of the larger economy.  So how does empowering shareholders help with that?

And just out of curiosity: Christine notes that "Section 955 requires companies to disclose employees and directors who engage in hedging investments regarding company stock." Were there reports of this kind of hedging actually happening, or is this a hammer in search of a nail?

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I certainly agree that the reform bill falls short in a number of important ways, and I also concur with Kim's assessment that the bill punts a lot of the significant issues to regulators.  This includes proxy access.  That is, with respect to proxy access, the bill does not spell out any particulars, but instead Section 971 grants authority to the SEC to issue proxy access rules under terms and conditions it deems appropriate to protect investors and safeguard shareholders' interest.  Should one view that grant of authority as a positive development?

To be sure, there is considerable debate about the relevance of proxy access to the financial crisis and recovery effort.  One the one hand, as the Wall Street Journal notes, some advocates of proxy access place "blame for much of the recent financial crisis on a lax culture inside corporate boards," and presumably believe that proxy access can counteract that culture.  On the other hand, opponents, like the head of the Business Roundtable, insist that provisions like the proxy access rule are "totally unrelated" to the financial crisis.  Even those who may acknowledge some connection between the financial crisis and issues of board accountability sought to be addressed by proxy access, nevertheless contend that the web of issues that triggered the financial crisis are far too complex to be resolved by a proxy access rule.

There is also debate about the benefits of the specific proxy access provisions contained within the bill.  Indeed, the provisions do not mandate proxy access, but rather toss the ball back in the SEC's court.  The SEC's history of proposing and abandoning proxy access rules suggest that it has managed to fumble that ball on a number of occasions (which may be good or bad news depending on your views with respect to this subject).   From this perspective, the reform bill may not have any impact on the passage of a proxy access rule.  However, proxy access advocates may nevertheless view the rule as a net positive for at least three reasons.  First, perhaps the SEC is in the best position to shape the specifics of a proxy access rule, and hence advocates would rather that the ball be in the SEC's court.  Second, the final bill leaves out the 5% ownership threshold that most proxy access advocates found objectionable.  Third, the SEC may have been waiting for the grant of authority to make its next move.  Indeed, just last week the SEC sought public comments on a variety of issues associated with proxy mechanics.  This release, coupled with the specific grant of authority by Congress, may be viewed as setting the stage for proxy access.  In this respect, the provisions may have been a necessary pre-condition to the SEC's proxy access rule.

Of course, the biggest area of contention has always revolved around the potential impact of a proxy access rule on issues of board governance, accountability, and misconduct.  At the very least, it does not seem likely that the rule will sit idle.  This report from the Wall Street Journal indicates that investors like Calpers are gearing up to take advantage of proxy access by generating a list of potential board candidates to nominate at poorly performing firms.  And what will happen if those candidates manage success in their election runs?  Opponents predict dire consequences.  In fact, in his proxy access discussion, Bainbridge quotes the National Association of Manufacturers as predicting that proxy access will unleash "an onslaught of activists trying to manipulate the proxy process to force corporate decisions that adversely impact shareholders as a whole in order to further their parochial social or political agenda."  Needless to say, proxy access advocates clearly hope for more positive developments. 

Ultimately, if the reform bill has managed to make proxy access a reality, then at the very least it will be responsible for finally resolving the long-standing debate about the benefits of such access.  Time will tell if such a resolution is a good or bad thing.

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